10-04: Game Theory for Global Climate Policy

This paper solves the global cap-and-trade game exactly as the public-goods game is normally solved and finds a problematic outcome. Abatement of greenhouse gas emissions is a global public good, and supplying a public good is a game with strong incentives to free ride. Adding a cap-and-trade mechanism to such a game makes the outcome less cooperative. It reduces total global abatement and polarizes the commitment levels of large and small countries.

Cap and trade also increases polarization of commitment levels that reflect differences in national incomes. Countries with relatively high pre-cap abatement levels commit to abate still more when a cap-and-trade policy is added. Low-abatement countries choose targets below their pre-cap abatement levels. The poorest countries and those with the lowest emissions adopt caps above business-as-usual emissions. These results parallel the current polarization of developed and developing countries.

As an alternative to the cap-and-trade mechanism, a global-price-target mechanism is considered. In the stylized form analyzed here, countries vote for a global price target and the lowest vote wins. Posting bonds makes the outcome self enforcing, and all countries price carbon at the target level. In a simple public-goods model, all countries vote for the optimal price target. In a more complex world with rich and poor countries, cooperation requires the introduction of a Green-Fund incentive. Linking its level to the level of the adopted price target induces poor countries to vote for the same target as rich countries. The outcome is quite cooperative and nearly efficient.